For years, pension products have been about saving for retirement, with a 1,001 different varieties of tax-advantaged savings vehicles.
In contrast, the purpose of all that saving – the deaccumulation phase of our lives — was not much catered for at all.
With a Stalinist lack of choice that would have made Henry Ford blush, pensioners were largely restricted to purchasing an annuity.
Income drawdown came on the scene in 1995, but only in a form that restricted drawdown amounts to limits set by the Government Actuary’s Department (GAD), in order to prevent retirees from running out of money before they died.
And while annuities and drawdown plans do admittedly come in slightly different flavours from provider to provider, by my count that still adds up to a magnificent total of, er, two distinct pension products.
But after years of minimal innovation in the world of deaccumulation products, I think we’re set to see that number of products increase.
How come? Read on.
Brave new world of pension planning
While you probably don’t need reminding of this, the UK’s liberal new pensions regime comes into force next April.
From then, retirees will be able to access their pension pots more or less at will.
Withdraw the lot, and blow it on a Lamborghini, to quote the infamous words of pensions minister Steve Webb? Certainly, Sir. Or Madam. What colour of Lamborghini?
GAD limits? Forget ‘em. At long last, your pension pot is yours to do with as you wish.
Subject to paying tax on the amount withdrawn – which can quickly tot up to a hefty amount if such withdrawals take you into higher-rate tax bands – there’s more or less total freedom.
Spend, spend, spend your pension
So what will people do with this freedom?
One option, of course, is indeed the Lamborghini (although personally, I’d sooner have a Cessna 172).
The usual suspects in the financial services industry have whipped up the usual froth with a slew of ‘surveys’ showing that people will be tempted to splash out on foreign holidays, pay off the kids’ university fees, and build a conservatory.
Personally, I’m dubious. Having saved all their lives, will people really splurge the lot on a trip to Thailand and a new kitchen?
The more sensible commentators, however, have added another option: still withdrawing the lot, but buying rental property with it.
In property-obsessed Britain, that’s an option with widespread appeal.
Denied the opportunity to be a BTL landlord during their working careers, some pensioners will see retirement as the ideal time to deal with dodgy builders, handle ungrateful tenants, and suffer prolonged income-sapping rental voids.
I jest. At least in part. But I don’t really think that the property option has legs.
Tax take on converting your pension into property
Because however alluring the property dream, there’s that tax hit to consider.
This will see the government claw back 40% of any pension withdrawal (after the 25% tax-free allowance) that takes an individual’s total income above £42,3661 —and 45% of any pension withdrawal that takes it above £150,000.
Yikes! As Hargreaves Lansdown’s Tom McPhail has pointed out, this would see an individual earning £40,000 a year paying a top rate of tax of 45% to withdraw in its entirety a pension pot of £300,000. (Worse, the effective tax charge would be 60%, due to the loss of the personal allowance affecting individuals with annual incomes of over £100,000).
Overall, the effective tax rate on that pension pot as a whole would be 32%.
Of that £300,000 pension, £95,750 would promptly go to the Chancellor, in tax.
A castle, not a pension
After that tax hit, the effectiveness of a property investment as an income-generating solution pales into inconsequence.
To prove the point, the ever-helpful Hargreaves Lansdown (who admittedly isn’t a disinterested bystander in all this) has produced a chart comparing the income from a £300,000 pension pot under three different scenarios:
- #1 – ISA and Drawdown: Take the tax free lump sum, invest it progressively in an ISA, leave the balance in drawdown, take an income from both the ISA and the drawdown.
- #2 – Property: Take all the money in one go, paying tax on 75% of it, reinvest in a property, live off the rental income.
- #3 – ISAs: Take all the money in one go, invest in funds and progressively reinvest it in ISAs, taking an income from the funds (taxed) and the ISAs (tax free).
Here’s what happens over a 20-year period:
Interesting, isn’t it?
For me, the two key takeaways are that the property income never really recovers from that initial tax hit, and that the ISA income – thanks to its tax-free status – progressively catches up with the drawdown option.
So where does that leave us?
In short, desperately hunting for some other sort of pension product – some way of getting an income, in my case while retaining my capital (so no annuities here, thank you) and not suffering an initial tax hit by withdrawing.
- Equities? Fine in theory, but subject to periodic worrying falls in capital value (45% in the 2008-2009 downturn, for instance), and periodic downturns in income flow.
- Some judicious mix of the two? Well, yes — but what about other asset classes, such as property? Some bricks and mortar might be good. And so on.
Funds can be dreamt up to do all that, of course. But how much will it cost to manage the resulting mix?
A charge of 1.75% per year, for instance, is about half the market’s present yield.
Not to mention the further income-sapping double-whammy of platform charges levied by some of the major fund supermarkets.
Shares in your pension: British Assets Trust
The changes in question directly stem from the new pensions regime we’re entering.
Simply put, British Assets Trust proposes to switch fund managers and reposition itself with a multi-asset portfolio, to deliver a pensioner-friendly quarterly stream of dividends that will (it hopes) grow over time.
To quote from the document that the Trust is putting to shareholders:
“The Board believes that [the] proposed strategy for the Company… represents an innovative way to capitalise on the very attractive opportunities presented by recent legislative changes relating to UK pensions, and … is well designed to address the issue of relevance and relative awareness in the post-RDR investment world. The Board believes that… the Company will attract a new investor base, and that the Company will grow, as well as deliver shareholder value.”
As an investment trust, British Assets can be held quite cheaply on most investment platforms and brokerage accounts, and fee-wise isn’t too expensive.
Inside a SIPP, it could throw off a reasonable income. One that is actually geared to the needs of retirees – unlike all those supposedly income-centric funds that investors perversely pile into looking for growth. (That’s you that I’m looking at, Mr Woodford.)
But what is especially noteworthy is that here we have a long-established investment trust – albeit one that is very much on the staid and steady side of the road – explicitly re-purposing itself to attract retirees after next April’s reforms.
Somehow, I don’t think that it will be the only one.
Also, if investment trusts can do it, then I’d hope products such as ETFs can’t be far behind.
And that’ll all be great news for DIY pension planners.
- Note: For the sake of simplicity, calculated as £10,500 personal allowance for individuals over 65, plus applicable earnings band. Note for pedants: you mileage may vary. [↩]